Imputed interest is interest implied by law. When an installment contract, such as a land contract or a mortgage note, fails to state an interest rate or sets an unreasonably low rate, the IRS will impute, or assign, interest at a prescribed rate (computed semiannually). The applicable federal rate depends on the term of the note, and is determined by the IRS and published monthly. This rule does not apply to installment sales under $3,000.00.
Buyers may deduct for tax purposes, even though no interest is paid, the imputed interest per annum on the unpaid balances. By reallocating the face amount of the note to part interest and part principal (buyer and seller agreement), the buyer may not only carve out an interest deduction but also reduce the basis of the property acquired as in an installment sale.